FINS3630 Lecture Notes - Lecture 8: Market Risk, Financial System, Issued Shares

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15 May 2018
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FINS3630 Notes
Lecture 1: An Overview of Financial Institutions
- Financial system:
o money (medium of exchange, unit of account, store of value)
o financial instruments (legal contracts used to transfer resources and risks between
suppliers of funds and users of funds)
o financial markets (places to buy/sell financial instruments)
o financial institutions (services to facilitate the flow of funds from savers to investors)
o central bank (monitor and stabilise)
channel savings to investments (efficient allocation of capital higher production
and efficiency) + allow economic agents to share risks
- direct finance: corporations borrow funds directly from households in financial markets by selling
the seuities lais o ops futue Y/A PRIMARY SECURITIES (liabilities for corp)
- information and monitoring costs
o high cost of information collection before transaction
o high cost of monitoring after the transaction
- liquidity cost
o LT nature of corp D/E
o Lack of liquid secondary markets creates disincentive to directly invest in corp
- Price risk
o Risk that sale price of direct claim will be lower than purchase price of that claim
(preservation of value of savings rather than earning high returns)
o Small size of household investments, they do not have the scale to diversify price risk
- Transaction costs
o Quod small sixe of investments
- Indirect finance: FI stand between lender and borrower- pooling large number of individual
savings- economy of scale to significantly reduce information and monitoring/transaction costs
- FI buys primary securities issued by corporations and issue secondary securities to lenders
(backed by primary securities FI holds) highly liquid and have very low $P risk
o ASSET TRANSFORMATION risk and liquidity
- Risk transformation: FI diversify unsystematic risk
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FINS3630 Notes
- Liquidity transformation: diversify source of funds (daily withdrawals and set aside cash without
liquidating entire LT investments at loss)
- Information problems
- Asymmetric information adverse selection (before transaction occurs- banks accept the bad
risks and price out the good risks)
- Solution: screening- requires lenders to be good at collecting and analysing information
specialise in screening and economies of scale to lower avg cost of info collected OR use of
collaterals
- Moral hazard asymmetric information (after transaction occurs- borrowers engage in risky
activities making repayment less likely), solution: monitoring
- Direct finance: brokers (agents compensated w commission), provide information and transaction
services
- Depository institutions (largest group of FI by BS)- ADI (authorised depository institutions)
oeial aks, savigs istitutios, edit uios payet sevies
o Liabilities of DIs significantly impact money supply (inflation)
- Finance companies: sell commercial paper and issue stocks/bonds
o Lend funds to consumers to purchase automobiles
o Organised by parent corp to help sell product
- Mutual funds: acquire funds by selling shares to many indiv and use proceeds to purchase
diversified portfolios of stocks and bonds
- Life insurance companies: financial hazards following death (annuities, premium)
- Property-causality insurance (GI): casualty
- Security firms and IBs: net suppliers of funds transfer funds to net users of funds at low cost and
efficiency- no security transformation- brokers intermediating between fund suppliers+users
o IB: raise debt/equity securities for cop/gov: origination, underwriting, placement of
securities in money/capital markets for corporate/gov issuers + securities trading
(brokerage/market making)
o Full service brokers (advice provided) vs. non-advisory brokers
- Regulation: negative externality, safety and soundness (diversification/capital adequacy), investor
protection regulations (disclosure, insider trading)
- APRA, ASIC (market
integrity, consumer
protection, set standards
for financial market
behaviour to protect
investor/consumer
confidence, administer
corporate law to promote
honesty/fairness in
co/markets), RBA
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Document Summary

Transaction costs: quod small sixe of investments. Indirect finance: fi stand between lender and borrower- pooling large number of individual savings- economy of scale to significantly reduce information and monitoring/transaction costs. Fi buys primary securities issued by corporations and issue secondary securities to lenders (backed by primary securities fi holds) highly liquid and have very low risk: asset transformation risk and liquidity. Liquidity transformation: diversify source of funds (daily withdrawals and set aside cash without liquidating entire lt investments at loss) Asymmetric information adverse selection (before transaction occurs- banks accept the bad risks and price out the good risks) Solution: screening- requires lenders to be good at collecting and analysing information specialise in screening and economies of scale to lower avg cost of info collected or use of collaterals. Moral hazard asymmetric information (after transaction occurs- borrowers engage in risky activities making repayment less likely), solution: monitoring. Direct finance: brokers (agents compensated w commission), provide information and transaction services.

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